A reader asked me to clarify my comments from this last video about possibly allocating more to absolute return if I think a bear market is imminent as opposed to normal benchmarking done by investment managers.
The answer has many facets and this may turn out to be difficult to articulate. The way I view benchmarking, I am trying to add value versus the benchmark we use (the S&P 500 for equities). At times like when the market is going up a lot it makes sense to look a lot like the index and not worry about adding value. This is a point I have made before.
The next time the stock market is up 26%, as it was in 2003, going up by 24% is a great result for helping you reach your financial goals.
The next time the market goes down by 26%, this is a normal bear market drop which is a point I have made many times and I see John Hussman mentioned it in his commentary dated Nov 12, it makes sense to look very little like the market.
The obvious dilemma is knowing when the market will do either of those things. As it is not knowable big bets become very risky. A point I have made before is it does not take much to change the behavior of a portfolio.
My preference would be to sell as little as possible in the face of a bear market, rather I would prefer to simply neutralize as much of the decline as possible. In practice this means selling a little and adding in some more double short which I have been very glad to own these last few months.
Additionally, adding in a couple more absolute return products, or as I have sometimes referred to them in their own world products that might go up 3-5% and pay out 4-6% or otherwise move independently of the stock market could also help offset declines. I have some cash raised to do this.
I have no expectation of being down zero during the next 30% decline regardless of when it comes. Miss a chunk or smooth it some out are a couple of phrases that describe what I would hope to do and the things I have done far have helped thus far.
To reiterate a point from before certain stocks going down a lot in a bear market would not be the concern, especially if they pay good dividends that are safe from being cut. My concern is with the overall mix.
If someone could guarantee you that a portfolio of ten stocks would be up 30% (compared to 20% for the market) but that one of the stocks would drop 80% (and you couldn't know which one), would you care about the one that dropped 80%? If your answer is yes then my ideas are not right for you.
Again the idea is to add value which during a bear market is to protect that bottom number on the position page as much as possible. As I think the odds of a bear have now increased I am more focused on protection and defense as I think about what's next and at some point the focus will shift to looking more like the index and going more on offense.
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11 comments:
Hey Roger--
Maybe I've missed it, but bonds don't seem to play much of a role in your thinking about defense. If we go recession/bear market, it would seem that the Fed would keep cutting rates, which should benefit bonds...?
Fed cuts could help bills and notes but bonds (maturities ten years and longer) is not as clear to me.
What you say makes sense of course but with the ten year at 4.22%, according to Yahoo finance, I don't think I want to bet on that going lower from here. It might stay put of course but lower seems like a high risk bet in terms of allocating new money.
I prefer the shorter end in general but rates there seem to be panicky low and have held off on buying new paper as some things have matured of late.
I guess I am say it is a tough time for bonds because prices are very high.
Excellent post. As I have been on a combination family visit and real estate acquisition trip from San Diego to Wilmington, NC I had not time to panic the past two weeks. Returning, I find my portfolios in good shape primarily due in part to many dividend paying non-financials, foreign securities and those "love to hate" GMAC short duration Smart Notes that populate my permanent and speculative portfolios.
I am wary of double shorts, but I can understand why many find them appealing. I prefer a dividend floor at this stage for domestic securities.
There is the beauty of owning and adding to one's rental real estate portfolio, but I have already beaten the drum here too often.
Roger,
Being an investment professional gives you a certain advantage. As an investor who has kept the same portfolio more or less for over ten years, it includes mutual funds, dividend producing stocks, and VTSMX. I find it very difficult to understand and make the "necessary" changes, so therefore I do not. One thing I did do quickly, I did buy PHO, only because I have been a farmer for many years and water is much more important than oil.
Bernie an investor who simply buy an index fund and never sells it will obviously capture the market (which has meant about 10% per year over the long term).
That kind of number for people who save properly is enough.
One of the biggest drawbacks in that scenario is that your account balance feels every down tick.
That does not change the long term out come but merely makes for a rougher ride.
That is ok. No one should do what they don't think they can do, just know what that means so there is no freak out at a bottom.
Perhaps I missed something, you say:
Additionally, adding in a couple more absolute return products, or as I have sometimes referred to them in their own world products that might go up 3-5% and pay out 4-6% or otherwise move independently of the stock market could also help offset declines.
What are some absolute return products in a bear or down market?
DBV might be an example, or MIC which I own, various long short pairings of sector ETFs to take the yield.
Do not construe these as recommendations.
I am down on the year now, F this.\\John
I keep coming back to DBV as a potential "absolute return" idea if there is a substantial market decline, but I can't quite get 100% comfortable with it.
The backtested data on DBV shows a low correlation to the market, and the index did well from 2000-2002.
However, lately it seems like DBV declines whenever the broad stock market declines:
http://stockcharts.com/charts/gallery.html?dbv
DBV declined during the Feb 07 correction, the Aug 07 correction, and has declined during this most recent correction. Doesn't exactly inspire alot of confidence that it will provide positive returns in a "down ALOT" stock market.
Any further thoughts/comments on DBV or other specific alternative absolute return vehicles.
I am a firm beliver of down at little is fine but down a lot is not fine. When you are down 10% you need to gain 11% to break even. If you are down 20% you need 25% and you are down 50% you need to gain 100% to break even. You can see 20% in one year and -20% in a later year does not mean you are break even. This is especially more important in retirement years when your total portfolio is larger(hopefully). Thus, lower volatility has always been my goal.
The thing with DBV that I struggle with is that for now yen strength equates to weaker equity prices. That won't persist for ever but that is the deal for the time being.
As far as the down 10% needing 11% to break even. Understanding that concept is important but 20% declines snap back in a couple of months quite regularly in market history--talking about fast declines.
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